Strategic business risk 2008 The top 10 risks for business In collaboration with: Strategic business risk 2008 — The top 10 risks for business About this report Risks are inherent in every forward-looking business decision so successful risk management should be an integral part of an organization’s strategy and operations — an important dimension of good management practice. There has been a great deal of work done in the area of risk management in recent years. Ernst & Young has been engaged in signicant global activity to clarify stakeholder perspectives, map management activities and identify leading practice from which all can benet. Likewise, many companies have invested signicant resources globally in risk and compliance initiatives. Financial risk and regulatory risk have been the focus of much of this effort. In both cases, there are externally determined rules and frameworks with which companies need to comply and emerging best practice guidance on processes and controls that can help. We have worked with many companies who have found that the challenge of compliance can lead to opportunities for performance improvement through improved processes and enhanced communication. Some companies are now looking more closely at their operational risks, prioritizing these and thinking about how they can manage and monitor these in a coordinated way, the result of which can again be opportunities for performance improvement. What is clear is that to gain further business advantage, companies must increasingly look at the extended risk universe, from nance and compliance risk — to operational and nally, strategic risk. A different perspective on strategic risk Our experience, however, suggests that strategic risk has not necessarily beneted from developments in management practice. Much that has been written about strategic risk seems to be at such a macroeconomic level that the implications for action by the management of a specic company can be lost. More signicantly, the different implications for companies operating in different sectors can be blurred. Someone’s challenge is frequently someone else’s market opportunity. We decided to explore the area of strategic risk from a different perspective. In collaboration with Oxford Analytica we focused on the strategic risks facing 12 of the world’s most important sectors: asset management, automotive, banking and capital markets, biotechnology, consumer products, insurance, media and entertainment, oil and gas, pharmaceuticals, real estate, telecommunications and utilities. These sector studies served as the primary source for the overall comparative report of our ndings. It is never the risk that causes damage or creates opportunities — it is how we respond. 1 Strategic business risk 2008 — The top 10 risks for business Contents The Ernst & Young strategic business risk radar 2 Scanning the sectors 3 The top 10 risks for business 8 Regulatory and compliance risk 8  Globalnancialshocks 10 Aging consumers and workforce 12 Emerging markets 12 Industry consolidation/transition 15 Energy shocks 15 Execution of strategic transactions 17  Costination 17 Radical greening 18 Consumer demand shifts 18 Thenextve  21 Conclusion 26 Contacts 28 Strategic business risk 2008 — The top 10 risks for business 2 We have found the use of the radar — our risk radar — to be a simple and useful device to allow us to present a snapshot of the top 10 strategic business risks for a company, a sector or indeed the global economy as a whole. The radar allows us to show both the scale of the challenge and its nature. To arrive at our ndings, we worked with Oxford Analytica to interview more than 70 analysts from around the world and from over 20 disciplines that shape the business environment, including law, nance, the sciences, business strategy, geopolitics, regulation, medicine, economics and demographics. The focus of our interviews was to identify the emerging trends and uncertainties that will drive the fortunes of leading global businesses over the next ve years. Our interviews were open-ended in that we did not provide a list of pre-determined risks for the analyst to rate. Rather we asked each analyst to tell us what he or she believed would be the most important strategic challenges for global business ahead. Many different risks and challenges were identied, with in excess of 40 by more than one analyst. In order to prioritize the top risks for each sector, panels of sector experts including journalists, researchers, advisors and our own Ernst & Young practice professionals rated the severity of each of the risks for the sector concerned. The risks that appear at the center of the radar are those that our panels believed will pose the greatest challenge to business in the coming year. Those on the outer edge — whilst not small and still in the top 10 — are considered to be of slightly lower priority. It rapidly became clear that not all strategic business risks are the same in nature. We have therefore also divided the radar into three broad sections: (1) macro threats that emerge from the general geopolitical and macroeconomic environment in which we all operate; (2) sector threats that emerge from trends or uncertainties that are re-shaping the specic industry; and (3) operational threats that have become so intense that they may impact the strategic performance of leading rms. We believe this distinction is helpful, whilst recognizing that these categories are not completely exclusive. Hence, we can present one radar for a company or sector, as collectively, these are the principle strategic risks that industry-leading rms must manage if they are to maintain their dominant competitive position. “Strategic Risk (str-t’jk rsk)— a risk that could cause severe nanciallossorfundamentally undermine the competitive position of a company.” The Ernst & Young strategic business risk radar M a c r o T h r e a t s O p e r a t i o n a l T h r e a t s S e c t o r T h r e a t s 3 Strategic business risk 2008 — The top 10 risks for business Risk weighting and risk prioritization Phase 1: • We asked the pool of analysts to list and to rate (on a scale of one to ten, with one having the least impact), the 10 most signicant trends or uncertainties that may impact companies, and to provide commentary on why these are important to their industry. • Analysts were then asked to list the ve most signicant business risks to rms within their industries — considering in particular those of a strategic nature — that might bring about shifts in the industry or put leading rms in peril of losing their position. A numerical rating was applied from one to ve. Phase 2: • In order to prioritize the top risks for each sector, panels of sector experts including journalists, researchers, advisors and our own Ernst & Young practice professionals rated the severity of each of the risks for the sector concerned. Panelists were asked to assign a numerical severity rating, from one to ve, based on the likelihood that a risk issue would lead either to severe nancial impact or undermine the competitive standing of the leading rms in their sector. The ratings assigned by each sector panelist were averaged to build the lists of top risks by sector. • The risks that were rated as having the greatest impact across the largest number of sectors were identied as the ‘top 10 risks for global business in 2008.’ Scanning the sectors We have assumed that a ‘scan’ is or should be the most appropriate collective noun for the resulting grouping of strategic business risk radars and present (overleaf) the results of this analysis for each of the 12 core sectors. We hope that what is immediately clear is the extent of variation between these 12 radar snapshots. The most signicant strategic business risk is different for most of them and the nature of those strategic business risks is varied for all of them. Variation in risk Close examination of the radars — individually and collectively — shows that there is no consistent list of top 10 strategic business risks faced by the sectors. It is not just the weighting of risk that varies, but the positioning and the nature of risk. Moreover, it is not just the sector-specic risks that vary, but the macroeconomic and operational risks as well. This does not surprise us or any who recognize the importance of sector in determining business challenges. Variation in signicance of risk We have highlighted one of the most signicant strategic business risks — regulation and compliance — in red. This makes it easier to see that for four of the sectors — real estate, biotechnology (biotech), pharmaceutical (pharma) and oil and gas — this is perceived as one of the top strategic business risks. Banking and capital markets, insurance and telecommunications (telecoms) also perceive these risks as having high impact. Other sectors including automotive (auto), consumer products and utilities believe that the same issue rates lower in their top 10 strategic risks. Equally, a fundamental shift in consumer demand (marked in green) is a top risk for consumer products, asset management and media and entertainment, but rates lower for many of the other sectors. M a c r o t h r e a t s O p e r a t i o n a l t h r e a t s S e c t o r t h r e a t s Monitoring drug safety Raising capital Product development and clinical trials Strategic transactions Accessing talent Protecting intellectual property Price pressures and access Demonstrating value Regulatory compliance Harnessing emerging markets Biotechnology Strategic business risk 2008 — The top 10 risks for business 4 Indicates regulatory and compliance related risks Indicates consumer demand related risks M a c r o t h r e a t s O p e r a t i o n a l t h r e a t s S e c t o r t h r e a t s Geopolitical or macroeconomic shocks Global financial shocks Difficulty of developing retail competencies Cost and pricing controls Poor execution of M&A Changing needs of an aging population Polarization between alpha and beta business models Growth of alternatives Rise of financial conglomerates as asset gatherers Innovation away from traditional asset managers Asset management M a c r o t h r e a t s O p e r a t i o n a l t h r e a t s S e c t o r t h r e a t s Corporate governance and internal controls failures IT risks Reputation risks Credit shocks and exposures Global financial shocks Geopolitical shocks Compliance and regulatory risk Competition from non-bank banks and specialists Increasing pressure on margins Global market liberalization and consolidation Banking and capital markets M a c r o t h r e a t s O p e r a t i o n a l t h r e a t s S e c t o r t h r e a t s Fuel price shocks Compliance risks Cost controls and cash flow pressures Workforce aging and escalating legacy costs Failed product launches Environmental pressures Emerging markets Consolidation, restructuring and poor execution of M&A Consumer demands Entry of private equity Automotive M a c r o t h r e a t s O p e r a t i o n a l t h r e a t s S e c t o r t h r e a t s Managing sourcing strategies Cutting edge IT Emerging markets strategies Pricing pressures and input price risks Strategic alliances and transactions Consumer demand shifts Shifting regulatory threats Marketing and branding Supply chain risks Product development and innovation Consumer products M a c r o t h r e a t s O p e r a t i o n a l t h r e a t s S e c t o r t h r e a t s Securities markets Emerging markets Regulatory intervention Geopolitical or macroeconomic shocks Channel distribution Integration of technology with operations and strategy Legal risk Climate change Demographic shifts in core markets Catastrophic events Insurance The Ernst & Young strategic business risk radars 5 Strategic business risk 2008 — The top 10 risks for business M a c r o t h r e a t s O p e r a t i o n a l t h r e a t s S e c t o r t h r e a t s Inability to control costs Corporate governance and internal controls Maturation of key markets M&A activity and entry of private equity Emerging markets Asset protection risks including piracy and digital intellectual property rights Consumer demand shifts Business model innovation Managing the infrastructure of new business models Backlash against globalization Media and entertainment M a c r o t h r e a t s O p e r a t i o n a l t h r e a t s S e c t o r t h r e a t s Fa ilure to generate sustainable revenues from new business models Inappropriate processes and systems to support new business strategies Privacy and security risks Inaccuracy in forecasting returns from infrastructure investments Decline in fixed and mobile voice ARPU Competition from internet companies Consolidation and M&A Regulatory risks Te chnological shifts Globalization of markets and services Te lecommunications M a c r o t h r e a t s O p e r a t i o n a l t h r e a t s S e c t o r t h r e a t s Human capital deficit Cost controls Worsening fiscal terms Competition for reserves from NOCs Political constraints on access to reserves Energy conservation Climate concerns Supply shocks Demand shocks Uncertain energy policy Oil and gas M a c r o t h r e a t s O p e r a t i o n a l t h r e a t s S e c t o r t h r e a t s Geopolitical shocks Global economic and market fluctuations Rise of private equity Increased complexity of real estate finance Green revolution Shakeout of real estate finance Regulatory and compliance risks Infrastructure investment challenges Volatility in emerging markets Inability to find and exploit global and non-traditional opportunities Real estate M a c r o t h r e a t s O p e r a t i o n a l t h r e a t s S e c t o r t h r e a t s War for talent Cost pressure Product diversion and parallel trade Regulatory risk Possible overriding of intellectual property rights Global pandemic Price controls and reimbursement levels Drug counterfeiting Product pipeline Adverse drug effects Pharmaceuticals M a c r o t h r e a t s O p e r a t i o n a l t h r e a t s S e c t o r t h r e a t s Energy politicization Entry of infrastructure and private equity Inability to respond to market liberalization Access to competitively priced long-term fuel supplies Compliance and regulatory risks Strategic exploitation of monopoly advantages by incumbent firms Damage or disruption losses Challenges of scale Climate change/ environmental awareness Cost or accessibility of capital Utilities Strategic business risk 2008 — The top 10 risks for business 6 Two of the sectors did not perceive a single macroeconomic threat oil and gas and insurance, however, perceive that half of their top 10 strategic business risks are macroeconomic in nature. Different types of risk It is also apparent that the nature of risk varies considerably between the sectors. Analysts in two of the sectors — biotech and consumer products — did not perceive a single macroeconomic threat as being in the top 10 strategic business risks, but were focused entirely on operational or sector-specic challenges. By contrast, the oil and gas and insurance analysts we interviewed indicated a much greater exposure to the global environment, and at least half of the top 10 strategic business risks for these sectors are macroeconomic in nature. Some sectors are undergoing dramatic transformation. Technological advances are driving change in the basic business models of many rms. In these industries, sector-specic challenges tend to dominate the risk lists. Particularly notable in this regard is media and entertainment. In ve other sectors — asset management, biotech, consumer products, pharma and telecoms — analysts indicated that half of the most signicant strategic business risks are also specic to their sector. This analysis highlights the importance of sector in driving strategic business risk analysis and management action. Hence, we have produced separate reports exploring strategic business risk in detail for each of these sectors. (Contact information for each report can be found on page 28). Given the observations above, what conclusion, if any, can be drawn from the aggregation of these sector ndings? We believe that there are two sets of valid conclusions to be drawn: Firstly, we believe that, because we have followed a consistent process and used a weighting system, it is possible to compare the riskiness of sectors one with another. Secondly, from consolidating the ndings of the 12 sector studies, it is possible to form a view of the 10 most important strategic risks across these sectors and hence for the economy, and this is the focus of the bulk of this report. 7 Strategic business risk 2008 — The top 10 risks for business Identifying the global top 10 By consolidating and aggregating the ndings of our 12 sector studies, it is possible to form a view of the 10 most important strategic risks across the sectors — concerns that will be common to leading rms in many industries. The table below shows the weighting of the top 10 strategic business risks across the 12 sectors that we studied. While many risks were unique to a sector, a few key challenges had a high or critical impact for many, or even all of the sectors. Hence the risks at the top of the chart are those that, according to the analysts we interviewed, will do the most to inuence markets and drive corporate performance in 2008 and beyond. Our analysis would suggest that the sectors that broadly have the greatest exposure to the top 10 strategic business risks are automotive and asset management, with four critical strategic business risks each. Insurance and real estate follow with three of the top 10 risks rated critical within their sectors. At the other end of the spectrum, for telecoms, none of the top 10 strategic business risks were marked as critical. This cannot, however, be used to denitively conclude that one sector is more or less risky than another. It may be that the unique sector-specic factors are in themselves more high risk than these 10. However, we can infer that, compared with what we believe are the most common strategic business risks, some sectors are more exposed than others. Critical impact High impact Medium impact Moderate impact Key Real estate Biotechnology Oil and gas Banking and capital markets Insurance Telecommun- ications Utilities Consumer products Media and entertainment Automotive Risks Industries 1 Regulation and compliance 2 Global financial shocks 3 Aging population 4 Emerging markets 5 Consolidation/transition 6 Energy shocks 7 Strategic transactions 8 Cost inflation 9 Radical greening 10 Consumer demand shifts Pharmaceutical Asset management Strategic business risk 2008 — The top 10 risks for business 8 The top 10 risks for business 1 Regulatory and compliance risk 2 Global nancial shocks 3 Aging consumers and workforce 4 Emerging markets 5 Industry consolidation/transition 6 Energy shocks 7 Execution of strategic transactions 8 Cost ination 9 Radical greening 10 Consumer demand shifts Top 10 strategic risks M a c r o t h r e a t s O p e r a t i o n a l t h r e a t s S e c t o r t h r e a t s Energy shocks Industry consolidation/transition Regulatory and compliance risk Emerging markets Radical greening Consumer demand shifts Aging consumers and workforce Cost inflation Global financial shocks Execution of strategic transactions As the greatest strategic challenge facing leading global businesses in 2008, the industry analysts we polled selected regulatory and compliance risk. This is being driven by an escalating regulatory burden in many markets, as well as numerous compliance challenges as companies extend their value chains well beyond Europe, North America, and the BRICs (Brazil, Russia, India and China). The possibility of regulatory intervention in sectors such as pharma, biotech, insurance, telecoms and utilities, is further elevating this risk. Such intervention could shape the competitive environment and drive fundamental change in business models. One telecoms analyst wrote, “Regulation has a tremendous effect on the competitive landscape, not only between incumbents and new entrants, but between countries.” In other sectors, the continued viability of current business models may be threatened by future regulatory decisions. 1 Regulatory and compliance risk In the following section, we explore the top 10 strategic business risks that have emerged from our study, and we share the thinking of some of the leading analysts to whom we have spoken. Continued on page 10 [...]...Beyond the horizon: forward-looking risk management Jim Fanning Ernst & Young There’s never been a more challenging time for banks and capital markets firms The complexities of the business continue to multiply The landscape keeps changing through globalization, the emergence of new markets, and the advent of cross-border expansion Add to the mix ever-evolving risk management,... flexible, efficient, and sustainable risk management framework that effectively meets not only today’s requirements but those of the future •  im Fanning is the Global Leader J of Ernst & Young’s Banking and Capital Markets Center Strategic business risk 2008 — The top 10 risks for business 9 ... executives spend their days scrambling to keep pace and their nights worrying about whether or not they are fully compliant and can meet expectations The concern is not unfounded Many of the largest institutions have multiple risk governance processes and infrastructures amongst various corporate and business units Because these operating models have sprung up over time as needs dictated, they often operate... focus only on what’s not working The future-state vision should be well-defined and communicated so that all parties are clear on what is to be achieved • Can expected benefits be tested? The goal here is to support the future-state hypothesis with empirical information in order to build a compelling case to present to senior management and the businesses With an eye on what the future operating model should... globally • Is there buy-in from the right stakeholders? Support from chief executives is important, but getting buy-in from key corporate control groups and business units is critical: they’re the ones that will make it work A few, forward-thinking institutions have recognized this need to streamline risk and control processes and present a more consolidated view to senior management and the board Consequently,... inefficiencies These models may prove to be insufficient tomorrow as cross-border consolidation adds another layer of complexity Competing regulatory regimes and variances in compliance requirements are just a few of the ways in which the demands and challenges of risk management will be compounded At the same time, companies will be expected to provide greater transparency and more accurate risk and control information... Consequently, they are beginning to take steps toward risk convergence It’s uncharted territory, however, so few, if any best practices have been established A critical foundational element is the creation of a common data structure, common terminology for risk and control process, and a common technology architecture In addition, the following questions can also help to guide the process: • Has the vision... Institutions can prepare themselves today to effectively manage the risks inherent in this future scenario by aligning or “converging” their current risk and control processes • Has a responsibility matrix been established? A matrix of current roles and responsibilities helps to visually identify existing duplication of risk management resources Risk convergence allows organizations to coordinate the various risk... and pragmatically In our experience, the result is reduced redundancy, which drives down costs, and, perhaps most importantly, allows more comprehensive, enterprise-wide risk reporting to senior management and the board While risk convergence is not a minor undertaking, it represents a major opportunity to more effectively mitigate current and future risks that otherwise could impact an institution’s... the businesses With an eye on what the future operating model should look like, it’s possible to move toward the desired end-state in incremental steps As each building block is put in place, efficiencies are gained and begin to multiply This approach can maximize the return-on-investment in the short term by avoiding large-scale investment while reducing waste and process redundancy Those financial . we respond. 1 Strategic business risk 2008 — The top 10 risks for business Contents The Ernst & Young strategic business risk radar 2 Scanning the sectors 3 The top 10 risks for business 8 . Strategic business risk 2008 The top 10 risks for business In collaboration with: Strategic business risk 2008 — The top 10 risks for business About this report Risks are inherent in every forward-looking. inflation 9 Radical greening 10 Consumer demand shifts Pharmaceutical Asset management Strategic business risk 2008 — The top 10 risks for business 8 The top 10 risks for business 1 Regulatory and compliance